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Wednesday, January 4, 2017

Peter Radford — Tectonics and Growth

My wife is reading Kahneman’s “Thinking Fast and Slow”, somewhere in which he relates his reaction when he first came across the bedrock of mainstream economics: rational microeconomic behavior. I must admit I had a very similar reaction. The description of human behavior that underpins modern economics is so bizarre that my first thought was that it must be some form of Monty Pythonesque satire. Surely, I thought, this is a joke and in a few pages all will be revealed. But no. Economics really is built on a foundation that to outside eyes is not just odd, but what appears to be a deliberate spoof.

What is even more strange, and those of you who listen to economists and take them seriously please suspend your sense of humor at this point, is that this total perversion of humanity is then taken as the essential starting point for all subsequent theorizing. Economists are all brought up nowadays to repeat the mantra that all “good” theorizing about the economy at higher levels — what economists call macroeconomic theory — has to be based on a foundation of theorizing at a lower level — what economists call microeconomics. So in the literature and in conversation it is common to come across the phrase that some higher level idea is based upon “micro foundations”.

Except that foundation is exactly what Kahneman and others laugh at.You would too if you spent any time at all thinking about it.

Which brings me to another point: economics is full of these oddities that anyone outside the profession would dismiss a priori as some form of ludicrous joke....

One consequence of economics being packed full of all this self-satirical nonsense is that it has great difficulty in explaining real world situations. The entire body of thought of economics includes useful tidbits that anyone can pick up and play with because they are common-sensical. But when we rely on economics to explain big important questions it begins to stutter and creak under the weight of all that absurdity.Which is why it fails to explain long term, or what I call tectonic, shifts.…

So, in the spirit of helping you frame your own thoughts about growth, and to help you ponder the tectonic shifts underway down beneath the froth of the surface phenomena of economics, here is the diagram I keep in front of me to remind where to look for problems and solutions. It is not a theory, it is a framework:

2 comments:

How to finally hammer down the nails in the coffin of Monty Python economicsComment on Peter Radford on ‘Tectonics and Growth’

Peter Radford puts his enduring perplexity about economics on record: “The description of human behavior that underpins modern economics is so bizarre that my first thought was that it must be some form of Monty Pythonesque satire. Surely, I thought, this is a joke and in a few pages all will be revealed. But no. Economics really is built on a foundation that to outside eyes is not just odd, but what appears to be a deliberate spoof.”

All this, of, course, is obviously true. But then, how could it happen and, much more important, how can we ― after 140+ years ― stop wondering and finally get out of Monty Python economics?

The inevitable failure of economics started with this fundamental methodological blunder: “It is a touchstone of accepted economics that all explanations must run in terms of the actions and reactions of individuals. Our behavior in judging economic research, in peer review of papers and research, and in promotions, includes the criterion that in principle the behavior we explain and the policies we propose are explicable in terms of individuals, not of other social categories.” (Arrow, 1994)

The definition of the subject matter translates into the following hard core propositions, a.k.a. axioms: “HC1 economic agents have preferences over outcomes; HC2 agents individually optimize subject to constraints; HC3 agent choice is manifest in interrelated markets; HC4 agents have full relevant knowledge; HC5 observable outcomes are coordinated, and must be discussed with reference to equilibrium states.” (Weintraub, 1985)

From these premises follows what Leijonhufvud famously called the Totem of Micro/Macro, that is, SS-curve―DD-curve―equilibrium. This construct is the analytical workhorse of economics and the one-size-fits-all explanation of how markets work.

For every person with keen scientific instincts, this construct is immediately and forever unacceptable. Economists, to their disgrace, have no scientific instincts at all. They simply swallow any junk. Obviously, the Walrasian axiom set contains THREE NONENTITIES: (i) constrained optimization (HC2), (ii) rational expectations (HC4), (iii) equilibrium (HC5). Every theory/model that contains a nonentity is A PRIORI false. By consequence, economics from Jevons/Walras/Menger to DSGE/RBC is false.

The microfoundations speak about human behavior. Now, human behavior is the subject matter of psychology, sociology, anthropology etcetera and NOT of economics. What is worse, NO way leads from the understanding of human behavior to the understanding of how the monetary economy works.

So, the definition of the subject matter has to be changed from Arrow’s methodological individualism to: Economics is the science which studies how the monetary economy works. Or, as Victor Beker puts it: “Economics deals with the study of the economic system. Why not starting by studying the economy as a system?”#1

First of all, the behavioral axioms HC1/HC5 have to be replaced by objective systemic axioms. The most elementary configuration of the economy consists of the household and the business sector which in turn consists initially of one giant fully integrated firm and is given by these three axioms: A1 Yw=WL wage income Yw is equal to wage rate W times working hours L. A2 O=RL output O is equal to productivity R times working hours L. A3 C=PX consumption expenditure C is equal to price P times quantity bought/sold X.#2

A1/A3 defines the pure consumption economy. Note that the set of foundational equations is entirely FREE of green cheese behavioral assumptions, i.e., the axiom set is purely SYSTEMIC.#3

From macro one arrives at micro by successive DIFFERENTIATION. Differentiation is top-down, aggregation is bottom-up. The methodologically correct way is to start with macrofoundations and then to differentiate.

The TRUE systemic macrofoundations A1/A3 replace the false behavioral microfoundations HC1/HC5 and Keynes’s false systemic macrofoundations.#4 From the true macrofoundations the WHOLE superstucture of economics has to be rebuilt.#5

To paraphrase a summary of Blaug: ‘At long last, it can be said that the history of general theory from Walras to Arrow-Debreu and on to DSGE has been a journey down a blind alley, and it is the set A1/A3 to have finally hammered down the nails in the coffin.’

Egmont Kakarot-Handtke

#1 Sourcehttps://larspsyll.wordpress.com/2016/11/03/why-should-economics-demand-what-harder-sciences-do-not/#2 See also ‘From microfoundations to macrofoundations’http://axecorg.blogspot.de/2016/04/from-microfoundations-to.html#3 For details see the short paper ‘How the Intelligent Non-Economist Can Refute Every Economist Hands Down’https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2705395#4 See ‘How Keynes got macro wrong and Allais got it right’http://axecorg.blogspot.de/2016/09/how-keynes-got-macro-wrong-and-allais.html#5 See cross-references Paradigm shifthttp://axecorg.blogspot.de/2015/02/essentials-cross-references.html